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Foolish Weekly Fund Wrap-Up

Is the ETF market getting speculative?

Welcome to the fourth installment of our weekly fund review, in which we take a look back at some of the more notable happenings in the fund world over the past week and tell you what it all means for Foolish investors.

Is the ETF market overheating?Remember back in the late 1990s when everyone and his brother seemed to be opening a gimmicky new mutual fund? Suddenly there were funds that focused on obscure areas of the market that you never knew you needed. That, as we now know, was just one of many signs of speculation in the market. And it appears to me that the exchange-traded fund market may be starting to show some signs of excess. As just one example, a new ETF was rolled out this week that focuses exclusively on Russian companies, the first of its kind. The Market Vectors Russia ETF (NYSE:RSX) will track an index comprised of the 30 most heavily traded Russian companies, including Lukoil, Gazprom, Mechel (NYSE:MTL), and Wimm-Bill-Dann Foods (NYSE:WBD). This new addition comes on top of the flood of new ETFs that have been brought to market in recent months, some of which are now sporting actively-managed investment strategies.

Foolish investors know that anytime you start to see new investment offerings getting more and more exotic, you need to exercise caution. The problem I foresee is that investors may buy into some of these highly focused ETFs without understanding exactly what they are getting, or how the funds are managed. Many new ETFs now have a distinct actively-managed tilt to them, and investors may be surprised if they buy in thinking they are getting a fund that is supposed to merely track an index. I think there may in fact be some fallout ahead in the coming months and years as certain ETFs fail to live up to their back-tested performance figures. How can you avoid this potential pitfall? Stick to the well-diversified, broad market ETFs, and stay away from funds with an overly narrow focus. You probably don't need an ETF devoted entirely to Russian companies in your portfolio (or steel companies or initial public offerings, for that matter). if you don't venture into obscure corners of the ETF market, you'll have a much better chance of avoiding any blow-ups that may occur.

Putnam's woes still not overPoor Putnam. Not only was it one of the fund companies hit hardest by the mutual fund scandals in 2003, but the resulting outflow of assets nearly killed the company off. Eager to restore investor confidence, the firm reached a settlement with the SEC, and back in February of this year, Putnam Investments was sold to Canadian insurer Power Financial for just under $4 billion. However, the unit is still being plagued by outflows, losing $3.5 billion from its retail funds in the first quarter of 2007. It seems that investors have still not forgiven Putnam for its role in the scandals of four years ago.

It's probably safe to say that Putnam's regulatory issues are in the past. Yes, there were some egregious offenses, but this was not limited to Putnam -- these scandals reached far and wide in the mutual fund industry and touched many firms with supposedly sterling reputations. If you tried to eliminate every fund company that had even a hint of impropriety associated with it, you'd have a very short list left over. Forget about Putnam's past troubles, and examine their funds on their individual merits. If you think your Putnam fund doesn't measure up, then go ahead and pull your money. But if you are just scared of the Putnam name, that is probably not sufficient reason to sell out. The past is the past, so focus on the present and on whether each Putnam fund is a good fit for you.

Fidelity adds three new "enhanced" index fundsFidelity Investments recently announced that it plans to launch three new enhanced index funds. These three funds -- which will use the S&P 500 Index, Russell 1000 Growth Index, and Russell 1000 Value Index as their benchmarks -- will also employ quantitative methods to tweak the stock selection, with the goal of outperforming their respective benchmarks. Thus, investors who want a little extra "juice" -- above and beyond what they could expect from holding their shares of Microsoft (NASDAQ:MSFT), Yahoo (NASDAQ:YHOO), and Time Warner (NYSE:TWX) in the same proportion as the market -- might find these new funds attractive.

On its own, I don't think the concept of enhanced indexing is a bad one. There is typically some room for a manager to add value above and beyond merely replicating the index. The thing that investors must understand is that with enhanced indexing, there is as much of a chance that the manager's calls will be wrong as there is that they will be right. Therefore, if you buy an enhanced index fund, you need to accept the possibility that you will fall short of the benchmark, potentially by a significant margin. You are taking a bet on the manager's active stock-picking abilities, and will be rewarded or punished accordingly. As long as you understand the added level of risk and potential reward that enhanced indexing brings, you can feel free to invest with confidence.

Now that you know what's happening in the world of mutual funds, take the next step and find out which funds represent compelling investments. The Fool'sChampion Funds newsletter brings that information right to your doorstep. Fool fund expert Shannon Zimmerman shows you how to find the winning funds you've been looking for. Start your free 30-day trial today.

Fool contributor Amanda Kish lives in Rochester, N.Y., and does not own shares of any of the companies or funds mentioned herein. Microsoft is an Inside Value recommendation, while Time and Yahoo Warner are Stock Advisor picks. The Fool has a disclosure policy.